The Impact of Political Relations on Multinational Divestment

• In Event: Political Risk and Foreign Direct Investment

Abstract

How do political relations affect foreign investment? While a number of studies suggest that geopolitics plays a crucial role in influencing economic relations between countries, a majority of the works either focus on bilateral trade flows or flows of foreign direct investment (FDI). In this paper, we study the impact of bilateral relations on investment at the micro-level, allowing us to disentangle the two components of FDI flows: multinational investment and divestment.

Multinational divestment – negative FDI manifested by foreign firms’ selling their assets and reducing their presence or leaving the host country is rarely studied by researchers, but is of particular policy concern because of its potential to foster financial instability, including job losses and capital flight. The consequences of poor relations may include both increased divestment as well as cessation of new investment, but divestment is both higher profile and more damaging to the host country than potential investment that does not materialize. We argue that due to sunk costs, foreign divestment is less responsive to bilateral political relations than foreign investment, and may even be completely unresponsive in the absence of host-country restrictions on foreign companies.

We also look deeper into divestment, and ask whether it matters if the foreign investor is state owned. We hypothesize that bilateral relations do not affect all the foreign investors in the same way. Using the energy industry as a case study, we illustrate the heterogeneity of foreign divestment. We classify foreign investors into four categories: private firms from energy-poor countries, SOEs from energy-poor, private from energy-rich, and SOEs from energy-rich. We argue that SOEs from energy-poor countries are more likely to divest compared to other types of investors because they have incentives to cut the reliance on energy from a rivalrous country and/or face political pressure from the host country.

To test these hypotheses, we will collect deal-level transaction data on firms operating in the energy industry during 1987-2017 as well as measures of bilateral political relations based on diplomatic events. This research provides broader implications for how we should think about the global economy with the backlash against globalization and the rise of state capitalism.

Authors

• Di Wang, University of Texas at Austin

• Robert J Weiner, George Washington University